Structured notes with principal protection are hot products these days. The financial crisis of 2008 left many investors with crippling losses, and the desire to find a safer place to invest their life savings. Marketed as a safer, high-yield alternative to low-yield savings accounts and CDs, structured notes were seen as the perfect safe haven.
But, as we discussed in a recent blog post, the products, often marketed with reassuring language like "principal protection," "minimum returns," or "capital guarantees," are complex and carry greater risk than investors realize. Regulators agree.
Lori J. Schock, Director of the SEC's Office of Investor Education and Advocacy says, "Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand."
John Gannon, FINRA's Senior Vice President for Investor Education says: "The current low-interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors, but retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment."
According to a recent investor alert, investors should be aware of the following risks when considering structured notes with principal protections:
- The principal protection promise is only as good as the issuer's creditworthiness. If the issuer goes bankrupt, you could lose your entire investment.
- Limitations to the principal protection promise may apply. In most cases, you're only eligible for the protections if you hold the product to its maturity date.
- The products have the potential to be highly illiquid. Don't bet that you'll be able to sell the product to a third party if you need funds earlier than the maturity date.
- Returns aren't guaranteed. You may earn more than the typical fixed-rate bond, but you could earn less or nothing.
- There can be hidden costs and fees associated with the products that will cost you money and lessen your return.